Volatility /n/  a term used by the media and “experts” to describe a large drop in price that they did not see coming.

The recent volatility in the market generated angst among many investors.  Is this the start of a new bear market or is it a buying opportunity?  Unfortunately, neither we, nor other experts, know for sure.  However, we would like to share some insight that might ease some investors’ anxiety.

First, recognize that sharp and sudden market moves are a normal part of market behavior.  For nearly four years, both animal spirits - bull and bear - have been hibernating.  It’s been that long since the Dow or S&P 500 Index moved more than 2% in a day, leading to the obvious conclusion that the last four years have been the anomaly and not the norm.  Historically such moves have occurred several times a year.

Second, focus on what matters – the direction of share prices over the next several years.  The short-term moves in the stock market get far too much attention in the media.  No one really knows how the stock market will behave over the next week, month or year.  However, we do have a strong conviction that  that the economy and corporate profits will be higher five years from now and share prices are likely to be higher as well.

Third, assess your tolerance for “volatility.”  Individual investors are wired differently.  Some can comfortably focus on the long-term – 10 or more years in the future.  Others, even though it’s painful, won’t lose sleep over temporary declines of 20 - 30%.  Still others get nervous if their portfolios decline by 10% – even if they recognize the decline is temporary.  If you are the nervous type, consider using bonds in your portfolio to dampen the cyclical downturns that inevitably come along from time to time.

Bull markets do not die of old age.  They are usually done in by excessive valuations or a contraction in the financial system.  Valuations today are not cheap, but they aren’t grossly expensive either.  We would say they are toward the higher end of a normal range. 

We also do not believe we are entering a credit crunch.  Inflation is subdued and the Fed should remain on hold for the foreseeable future.

Trouble in the sub-prime mortgage market has the potential to disrupt the flow of liquidity to the financial markets, but only if there were a contagion effect and credit became difficult to obtain for qualified borrowers.  Our best guess is that any flow-through effects will be limited.

So, we offer these suggestions:

1. Accept that sudden, sharp moves are part of normal market behavior
2. Assess your tolerance for risk and use a mix of stocks and bonds that matches your temperament

Focus on the next several years, not the next several months.

Foothills Asset Management’s commentary is provided for informational purposes only and should not be construed as investment advice. Statements that are non-factual in nature constitute only current opinions that are subject to change without notice. Foothills assumes no responsibility or liability from gains or losses incurred by the information herein contained. You should consult with your own financial advisor before making any financial decisions, including investments or changes to your portfolio.